Bernanke to Capitol Hill: Back to the Very Beginning

Let's start at the very beginning
A very good place to start
When you read you begin with A-B-C
When you sing you begin with do-re-mi

-The Sound of Music (1959, music by Richard Rodgers, lyrics by Oscar Hammerstein II)

Investors used to think that starting at the very beginning meant examining corporate earnings. After all, buying stock in a company (or through a stock mutual fund) is a bet that the company will increase its ability to earn money over time. Yet there is ample proof that companies are having a harder time making money by selling more goods and services and have instead been relying more on cost containment and financial engineering to meet their earnings objectives.

S&P 500 corporate profits are expected to rise 2.9 percent in Q2 vs. a year earlier, according to analysts polled by Thomson Reuters, which would be a slowdown from 5.4 percent in Q1 and 6.2 percent in Q4. But those diminished earnings are coming on projected revenue growth of only 1.6 percent.

“If companies are having a harder time making money, then why is the stock market rising?” asked a caller to my radio show. The answer to that question requires that we start at another beginning…or with Ben Bernanke. Early this year I jotted down 7 reasons why the stock market rally could extend well into 2013.

(1) (2) (3) The Federal Reserve is maintaining its low interest-rate policies (including the monthly purchase of $85 billion worth of bonds) until employment improves substantially

(4) Japanese officials have started to address the country’s multi-decade economic stagnation

(5) Europe is no longer on the precipice of disaster

(6) The much-feared hard landing in China never came to fruition

(7) U.S. housing is finally contributing to economic growth

You get the joke…Ben Bernanke’s Federal Reserve is responsible for the lion’s share of the stock market move. Without easy monetary policy in place, all of the other factors would not have boosted stocks to the levels that we are seeing now. Last September, the Fed launched its current round of bond buying (QE3) and also said that it would maintain low short-term interest rates until mid-2015. The announcement and the subsequent December pledge to keep the program open-ended sparked a rally in global equities.

Everything was honky dory until May 22, when during congressional testimony, Bernanke raised the prospect that the central bank could downshift from its accommodative policies, if economic data were to improve. The subsequent 7 1/2 weeks were volatile for every asset class, with most (bonds, gold, emerging stocks) heading lower and U.S. stocks, which were on a steady march higher, tumbled about 7 percent from their intraday record highs reached in late May.

If the boomerang stock market started its journey with Bernanke’s taper talk, it makes sense that markets would make the round trip after another Bernanke speech. Last week, the Chairman underscored that the central bank would continue to pursue highly accommodative policies for the “foreseeable future,” due to a weak labor market and low inflation. That time, investors took Bernanke at his word and pushed up U.S. stock indexes above pre-May 22 levels and the Dow and the S&P 500 even scored new nominal closing high levels.

Here we go again…

Today Bernanke is back on the hot seat for his semi-annual testimony to the House and tomorrow he heads to the Senate. Don't be surprised if the Chairman talks about the slow growth economy (GDP increased by only 1.8 percent in Q1 and probably by a paltry 1 percent in Q2) and the improving, though still-weak labor market. Although the economy has added an average of 202,000 new jobs per month this year, the broad unemployment rate (includes the official rate plus "marginally attached workers," those who are neither working nor looking for work, but say they want a job and have looked for work recently; and people who are employed part-time for economic reasons) jumped to 14.3 percent last month.

Bernanke is also likely to draw a distinction between tapering the Fed's bond buying, which if the economy improves, could begin at either the September or December Fed meeting; and raising interest rates, which is not likely to occur until 2015. While Bernanke and company will have a lot more data to chew on between now and the September 17-18 FOMC meeting, including two more employment reports, investors will hang on his every word.

Meanwhile, it’s worth noting that while so much attention is focused on stock market records, a Pew Research survey this spring found that over half of Americans (of 53 percent) say they have no money at all invested in the stock market, including retirement accounts.

For more, go to JillonMoney.com

Image by Flickr User DennisSylvesterHurd